IRS demands day traders record
every transaction By Cora M. Barnhart 
Bankrate.com

If you're a day trader, you know all about risk.
But here's one sure thing -- the IRS wants a mound of paperwork
from you.

Most taxpayers aren't true day traders, but
investors. To be a trader -- and to qualify for the special tax
treatment that traders get -- you must profit primarily in swings
in daily market movements, and personally engage in the purchases
or sales.

Taxpayers who spend a lot of time trading, especially
those who don't have full-time jobs, are more likely to qualify
as "true" day traders in the eyes of the Internal Revenue
Service. Basing trades on profits from short-term market changes
as opposed to long-term gains and dividend income also increases
the chance of being perceived as a trader by the IRS.

Mark-to-market
Once you attain trader status, the IRS has special rules for you,
some favorable, some less so.

The favorable ones give traders a break on capital
losses.

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Most taxpayers who sell a stock at a lower price
than they paid for it incur a capital loss. The loss reduces part
of the taxes they owe.

If someone buys and sells the same stocks a
lot, though, there is a problem. Generally, anyone who purchases
the same stock 30 days before or after selling it transforms the
sale into a "wash" in the eyes of the IRS. This could
make it impossible for someone who is constantly flipping over stocks
to ever claim a loss.

The IRS gives a break to day traders, however.
They become "mark-to-market" traders and are exempt from
the wash-sale
rule.

How does this work? On the last trading day
of the year, a day trader pretends to sell all holdings. He records
all sales and gains that result, even though he still owns the stocks.
His new year begins without any capital gains or losses. The trader
then pretends to "buy back" all of the stocks that he
never sold.

There is another tax break for mark-to-market
traders. Most stock investors can only claim up to $3,000 as a capital
loss in a given year. If someone is a mark-to-market trader, though,
there isn't a limit on capital losses. This doesn't eliminate all
the pain from a bad year, but it should ease it a bit.

The
paper chase
Now, the really fun part. A lot of trading is bound to mean one
thing to the IRS -- a lot of paperwork.

It doesn't stop at the loss or gain from each
trade. The IRS expects all the details from every transaction, including
each security's description, purchase date, cost, sales proceeds,
and sales date.

Traders have two ways they can approach this
task -- do it by hand, or with a computer assist.

Taxpayers can report their trades by hand on
Schedule D; mark-to-market day traders use Form 4797. Regardless
of which filing route you use, you'll have to record every single
trade, reporting net short- and long-term gains and losses, total
sales proceeds and the total cost of shares. You also should attach
a statement offering to provide details on request.

If this sounds like a nightmare, it could provide
the push you need to use a computer
program for your taxes. Several programs allow you to download
trading data from various online brokers. You can then use the tax
program to transfer all the data onto your return.

Not only is the computer route likely to take
less time, but it could prevent some unwanted scrutiny from the
IRS. Keep in mind that the IRS is going to be trying to reconcile
a tax return completed by hand with any information reported by
your broker. Overlooking a trade or incorrectly reporting a detail
could mean having to spend a day answering questions from the IRS.
And, of course, that could be the one day that you make a killing
in the market.